Thousands of Americans in debt over their heads are turning to nonprofit credit counseling agencies to help them avoid bankruptcy and return to solvency. But for many, that move is leading to more financial woes.
A new breed of credit counseling agencies is more interested in making a buck off troubled consumers than in helping to rescue them from financial distress, consumer advocates say.
These agencies are charging exorbitant fees, failing to disclose who is profiting and how from rescue plans and, in some instances, failing to pass debtors' payments on to creditors on time, experts say.
At the same time, some of these nonprofit agencies are acting more like for-profits by paying executives lavish salaries or steering millions of dollars in business to for-profit companies run by friends or relatives, critics say.
"The IRS has given out tax-exempt status to these companies without really checking whether they are filling their tax-exempt purpose," said Joseph Rooney, deputy commissioner of the Division of Financial Regulation, which regulates the groups in Maryland.
"The nonprofit status is a linchpin. In the wrong hands, nonprofit status is a license to steal," said Eric S. Friedman, investigative administrator for Montgomery County's Division of Consumer Affairs, who has become a national authority on credit counseling groups.
Alarmed by a rising tide of complaints, consumer advocates are pushing for reforms.
Congress is considering legislation that would require credit counselors to be registered and would force greater disclosure of fees and relationships with for-profit affiliates.
States also are pursuing regulation. Maryland began licensing nonprofits last month, despite objections from some players.
The Internal Revenue Service and the Federal Trade Commission issued an alert to warn consumers about unscrupulous counseling agencies last month, and the IRS said it is stepping up reviews of whether counselors merit nonprofit status.
Focus on AmeriDebt
Much of the recent criticism has focused on AmeriDebt, one of the largest debt counselors in the country, which has its headquarters in Germantown, Montgomery County. It spends millions of dollars advertising its services, its annual report to the IRS shows.
Illinois and Missouri sued AmeriDebt this year, accusing it of behaving like a for-profit business and charging high and hidden fees that push clients deeper into debt.
Disputing the allegations, AmeriDebt said it has helped more than 300,000 clients and given free service to tens of thousands.
Three weeks ago, AmeriDebt said it would stop enrolling new clients because "negative publicity" made it difficult to serve new customers.
The nonprofit said it would cut its staff of 50 to about a dozen and focus on serving 92,000 current clients.
"They have become the poster child for bad credit counseling," said Travis Plunkett, legislative director for the Consumer Federation of America.
"We think there are problems that go well beyond AmeriDebt."
Service by phone, online
Credit counseling has been around for decades, but much of the help that was once offered face-to-face is now given by phone or online.
The agencies typically negotiate reduction or elimination of interest charges and late penalties with credit card companies. Debtors make monthly payments to the agency, which pays the creditors.
Card companies help fund the agencies by paying "fair share" - a percentage of the debt recovered. Until the 1990s, fair share was 15 percent.
Traditionally, credit counseling agencies have poured any surplus funds into free counseling and education programs.
The counseling industry began a period of rapid growth in the 1990s, as card debt soared and the Internet expanded the reach of counselors.
Now, Americans carry about $731.5 billion in card debt, more than triple the amount in 1990, and the number of counseling agencies is estimated at 1,500, up from 200 a dozen years ago.
Experts differ over what proportion of this new army of counselors is overcharging and self-dealing.
"Every industry has bad players. But usually they are the exception to the rule. In this industry here, it's just the opposite," said Friedman.
Jim Godfrey, executive vice president of the Consumer Credit Counseling Service of Maryland and Delaware, sees it differently.
"There are a lot of really good counseling services that exist across the country," he said. "The whole industry is being painted with the same brush."
As counseling has grown, its economics have changed. With more debtors making payments through plans, creditors saw their fair share expenses rising and began slashing payments to nonprofits, credit experts said. Today, the average fair share is 6 percent to 8 percent, experts said.
Joint study of industry
With that income down, credit counselors have trimmed services and begun charging fees, the National Consumer Law Center and the Consumer Federation of America reported in a joint study on the industry this year.
The National Foundation for Credit Counseling, the trade association for the more traditional agencies, said its members typically charge $23 to set up a debt plan and $14 a month for account maintenance.
Others take the client's first monthly payment, which can be hundreds of dollars, as a set-up fee and charge a monthly fee after that.
AmeriDebt said it requests contributions of 3 percent of the total debt as a set-up fee plus a monthly fee of $7 for each creditor, with the total not to exceed $70 a month.
Consumers complain about the fees and other practices.
Christina Davis, 33, of Waldorf, had about $25,000 in debt two years ago when she found AmeriDebt on the Internet and signed up.
Davis said she wasn't told that her first payment of $340 would not go to her creditors, but was kept by AmeriDebt as a set-up fee. That put her behind in payments.
On top of that, she said, AmeriDebt didn't pay her creditors on time and triggered late fees.
"When I called [creditors] to dispute the late fees, that's when they said, 'Unfortunately, it's still your responsibility to make sure the payment is being paid,'" she said.
She abandoned AmeriDebt last year. The nonprofit reimbursed the $300 she owed in late fees, but she said she's worse off than before. "My credit wasn't bad before, and now it's damaged from them," she said.
Adam Viden of Riverbank, Calif., said he'd rather file for bankruptcy than use credit counseling again. Viden, too, turned to AmeriDebt in 2000 when he had about $12,500 in credit card debt.
His voluntary contributions to AmeriDebt didn't seem voluntary, the 27-year-old said. "They presented it where if you didn't pay that contribution, then you wouldn't be getting their service."
AmeriDebt didn't warn that a debt plan could actually hurt his credit, Viden said. "It's a big red flag for a lot of companies."
Worse, he said, AmeriDebt was late paying some creditors. "Prior to them, nothing was late. I might have made the minimum payment, but at least it was on time," he said.
Asked about Davis' and Viden's complaints, AmeriDebt said it doesn't comment on specific cases. Unhappy clients should complain directly, the agency said.
Both Davis and Viden described their treatment by AmeriDebt to the Better Business Bureau of Metro Washington, which by mid-October had received 237 complaints this year about AmeriDebt - nearly double the number it had received in 2002, the BBB said.
"AmeriDebt, it's safe to say, is one of the most complained-about debt credit counseling firms in the entire United States," said Edward Johnson, president of the BBB's Washington office, which gives AmeriDebt an unsatisfactory rating.
AmeriDebt spokesman Scott Stapf said the rise in complaints is not surprising because AmeriDebt has had negative publicity.
And supporters say problems are few compared with the thousands AmeriDebt serves.
"AmeriDebt has done a quality job and they get tarred unfairly," said Michael J. Malesardi, of the Ballenger Group in Frederick, which does data processing for the agency.
IRS steps in
Consumer advocates applaud the IRS announcement that it is taking a closer look at the nonprofit status of the counseling groups.
"It's a good first step," said Plunkett.
Being a nonprofit is often seen by consumers as a seal of approval.
"When consumers hear that a credit counselor is a nonprofit, they let their guard down," said Bennett Rushkoff, senior counsel at D.C.'s Office of the Corporation Counsel.
Under a new law last month, Maryland began licensing nonprofit credit counselors that help debtors here. So far, 25 have applied for a license out of more than 1,200 groups contacted about the new law.
Maryland now allows nonprofits to charge limited fees for services - no more than $50 to set up a repayment plan and monthly maintenance of up to $8 per creditor, not to exceed $40 per month.
Large nonprofit balks
Cambridge Credit Counseling Corp., a large nonprofit based in Agawam, Mass., is balking at the new rules.
In a recent letter to state regulators, Cambridge said it doesn't come under Maryland law because it doesn't have offices here. It also objected to the fee limits, saying they could block service here.
(Cambridge officials were unable to say how many Maryland customers they have.)
Cambridge made similar arguments in a lawsuit it filed in Kansas last year, challenging a state law that prohibits fees. Cambridge has more than 800 customers in Kansas and collected about $87,000 from Kansans in 2001, according to court records. In September a federal court sided with the state when Cambridge challenged the law.
A Cambridge client pays an initial fee equal to the first month's total payments to creditors. After that, Cambridge keeps 10 percent of each monthly payment and forwards the rest to creditors.
If clients make on-time payments for six months, Cambridge will rebate half the amount it receives in fair share to the client. This helps clients, on average, to recoup most of their up-front charge, said Cambridge officials, adding that the nonprofit's fees allow it to provide high-quality service to consumers.
Warned of IRS audit
Cambridge is one of the largest credit counseling nonprofits, with revenues totaling $53.8 million for the fiscal year ended July 2002, according to IRS filings. That's up from $38.9 million the previous year.
Cambridge was warned by the IRS of an impending audit in May but that review hasn't happened yet, said Cambridge spokesman Montieth Illingworth.
Cambridge has close ties to for-profit businesses owned by the agency's founder and president, John Puccio.
Cambridge paid one of Puccio's companies $10.9 million for marketing and advertising last year and paid $8.9 million to another Puccio business that provides account processing.
Puccio and his brother Richard, Cambridge's strategic planner, each earned $624,000 last year from the nonprofit, double their pay the year before. Each also received more than $300,000 in compensation from for-profit affiliates.
Cambridge paid $5.1 million to the brothers last year as partial payment for some business assets that the Puccios had sold to the nonprofit when it was starting up, company officials said.
Better for customer
The sale of assets and business arrangements between the nonprofit and for-profit companies have been reviewed and approved by Cambridge's outside auditors, said Illingworth. The Puccio brothers' pay also is in line with compensation at nonprofits and for-profits of comparable size, which follows IRS guidelines, he said.
The affiliated companies offer the most cost-effective services, and in the end that benefits consumers, Illingworth said. Those relationships are fully disclosed to the IRS and to the four states where Cambridge is licensed.
"Not once has anything been found improper or outside the regulations that are designed to protect consumers," he said.
Still, some question the arrangements.
A Virginia couple, who sued Cambridge in U.S. District Court in Massachusetts early this month over the handling of their account, claimed the nonprofit's primary purpose is to make money for the Puccios "to such an extent that Cambridge's practice of advertising its nonprofit and tax-exempt status amounts to a fraud upon the public."
Cambridge spokesman Illingworth called that suit "a legal hustle" perpetrated by class-action attorneys and plaintiffs.
Friedman, the Montgomery County credit counseling expert, believes the Cambridge executive salaries are out of line.
"To me it's shocking to see a salary like that at a nonprofit that's supposed to be operating in the interest of the public," he said.
Not everyone in the industry agrees that Maryland's fee limits are unreasonable.
"We think the fees that the law allows are more than reasonable," said Godfrey, of the Consumer Credit Counseling Service of Maryland and Delaware, the only nonprofit thus far to be licensed under the new Maryland law.
Godfrey said certified counselors at his agency spend up to an 1 1/2 hours counseling a consumer in person or over the phone before determining what help the debtor needs.
This year, the agency began charging a fee of $15 per month for its 17,000 clients enrolled in a debt management plan.
Tips on finding a good credit counseling agency:
Take the time to shop around.
Look for a variety of services.
Check out all costs.
Nonprofit status or an affiliation with a particular trade group does not guarantee quality.
Demand good service.
Ask about privacy.
Find out about employee compensation.
Get the specifics on credit concessions.
Keep an eye on the agency after you sign up.
Ask about how credit counseling will affect your credit report or score.
Source: National Consumer Law Center and Consumer Federation of America